Video Transcription

My name’s Jeff Goldstein of the Goldstein Law Group. Our firm specializes in representing only franchisees in franchise disputes and franchise counseling. This evening I wanted to discuss with you the issue of due diligence, that required by a franchisee before purchasing a franchise.

There are three general areas that I’d recommend based on the firm’s experience, in my experience that the franchisee needs to explore. The first is to examine an FDD, that’s a franchise disclosure document. In the old days, it used to be called the UFOC. These documents are disclosure documents prepared by franchisors providing some information for franchisees to examine before they purchase a franchise. While the information is clearly insufficient in terms of the required disclosures, notably regarding profits and revenues, it does provide some information to a franchisee. And it needs to be reviewed by both a franchisee and a franchise lawyer. The second area has to do with communicating with other franchisees, both previous franchisees as well as existing, current franchisees. Your previous franchisees are obviously gonna be the ones who are gonna give you the straight scoop on things. You’re able to find those in the franchise disclosure document under one of the items that’s prepared and required by a franchisor, and we’ll discuss later what types of information you should be getting from those people. There’s also with regard to that issue, the problem that franchisees and former franchisees are under confidentiality orders, with regard to settled cases, and it’s not likely they’re permitted legally to speak to you when you call them. The other issue that I’d recommend highly with respect to due diligence, is to contact a lawyer who specializes in representing only franchisees and franchise disputes. This person should have many years of experience in representing franchisees, and negotiating franchise agreements for them, and seeing the pitfalls, if that person is a litigator, that arise out of a failed franchise relationships.

So what I’d like to do initially is to focus on the due diligence of a franchisee with respect to costs. These are in several categories. First would be what I’d call initial costs. These are the costs that many franchisors require a franchisee to pay a lump sum payment, could range from 5,000 up to 60,000 and 70,000. These are fees that go to the franchisor before anything is accomplished, before the franchisor does anything for the franchisee. And many times the franchisee will lose any franchise fees paid as an initial cost if the deal goes sour before a contract is signed and before the franchise even opens. So these are significant costs that can sometimes be negotiated with respect to a deal before the deal goes bad. There are many franchisees who have come to me after they have signed a franchise agreement and it automatically says that the franchisee will lose his or her payment, the initial fee, whether or not the franchisee moves forward and opens. A lotta times it’s even before a franchisee can find an acceptable site. And in those cases, that money is gone, it’s sort of a pit. So that’s an important issue that you need to look at.

There is also the issue of continuing royalty fees. And there are many things that fall under that and there are many different ways a franchisor can charge those and a franchisee will have to pay. It can be as simple as 3% of gross revenues, or 4%, or 5%, there’s nothing magic to the number, up to a situation where they are at great points. So the franchisee would pay 5% up to a particular number 100,000 of revenues, and then 3%, and then 2% based on achieving some spectacular revenues. Those are usually a situation where there’s a proportion of the franchisee’s gross revenues. So this doesn’t count whether or not the franchisee actually does or doesn’t make a profit. So if you’re making gross revenues of say $100,000 and it’s 10%, you’re gonna pay the $10,000 whether or not your costs are $110,000, and you’re losing $10,000 a year. There’s almost no franchise agreement that I’ve seen that at least in the boilerplate prototypical agreement, is going to permit the franchisee not to pay fees or less fees if the franchisee is not making a profit.

In general, there are also what I would call advertising fees. These can be called marketing fees, or as I say, they can be called co-op fees, they can be called national marketing, national advertising fees. It’s a broad umbrella for the fees other than the royalties that the franchisee is gonna pay for people to understand and know that that franchisee is selling a certain type of good. Thanks for being with me today. And if anybody has any questions, feel free to give me a ring. Thanks again.

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Goldstein Law Firm, PLLC

1629 K St. NW, Suite 300,
Washington, DC 20006

Phone: 202-293-3947
Fax: 202-315-2514

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